NatWest Markets

NATWEST MARKETS, the largest clearing bank in the United Kingdom in the mid-1990s and a financial trading unit of National Westminster Bank of London, specialized in corporate, treasury, and investment banking. In 1997, it discovered mispricing errors in interest rate options trades that dated back to 1994. The errors were subsequently traced to a rogue trader who had elevated his paycheck through fraud and a manager who had neglected his duty to supervise.

Kyriacos Papouis was a relatively low-profile, and low-paid, London-based trader in the rate risk management division of NatWest Markets. He earned an annual salary of about £80,000. In 1996, [Page 560]he left NatWest Markets just before the end of the year for a similar position at Bear, Stearns, a worldwide investment banking and securities trading and brokerage firm. By leaving, Papouis lost a projected bonus of £100,000. This bonus, a sum that surpassed Papouis's salary, came from the profits that he had supposedly generated for NatWest Markets by making trades with the firm's capital in the highly volatile interest rate options market.

Shortly after Papouis left, NatWest Markets discovered that he had lost about £50 million of the bank's money. In time, a full investigation would reveal that Papouis and his manager, Neil Dodgson, had actually sustained losses of £90 million by trading options and swaptions. (A swaption is an option on a swap, usually an interest rate swap, which is an agreement to exchange net future cash flows.)

Papouis, who traded German Deutschemark interest rate options and swaptions, had mismarked option positions in the bank's books in a concerted attempt to cover up the losses. Dodgson, who traded Sterling (GBP) interest rate options and swaptions, also mismarked positions and failed to exercise the “due skill, care and diligence” required of him by his regulators at the Securities and Futures Authority (SFA). Poor trading and adverse market movements caused the damages, while weaknesses in operations and internal controls had permitted the crime to occur. The losses were confined to interest rate option trades at NatWest Markets. No third parties lost money.

The chaos of a bank trading room might lead to understanding how a low-level broker could hide £90 million in trading losses from the scrutiny of supervisors, as was the case at NatWest Markets.

News of the scandal became public in February 1997. The case pointed out the danger of paying traders large bonuses dependent on the profits they generate, and giving them wide discretion over the risk that they take with their employer's capital. NatWest Markets insisted that it knew nothing of the loss-making trades. Papouis was suspended from Bear, Stearns. He was subsequently expelled from the SFA and fined £50,000 plus costs of £2,500. The less culpable Dodgson received a formal reprimand, a fine of £5,000 and was ordered to [Page 561]pay costs of £2,500. Dodgson and a number of senior managers at the bank left their positions under pressure. The SFA heavily criticized NatWest Markets for its control failings. It discovered that NatWest Markets risk management process had failed to identify a clear case of mispricing for almost a year and then failed to spot the concealment of losing positions because of “significant and widespread non-compliance with internal minimum control standards.” It fined the bank £420,000 including costs.

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